TIPS OF THE TRADE: QUALIFYING FOR THE PARENT-CHILD EXCLUSION BY SELLING TRUST PROPERTY TO A BENEFICIARY PURSUANT TO A RIGHT OF FIRST REFUSAL

By Yvonne A. Ascher, Esq.*

Often a decedent wishes one or more of his children receive the family home or other real property as part of their inheritance, while retaining the current property tax assessment. One accepted planning technique to qualify a transfer of trust property to a child for the parent-child exclusion, where the value of the property otherwise would exceed the child’s distributive share, is for the settlor to grant a right of first refusal to a child in the trust document.¹ This is in contrast to trying to achieve a qualifying transfer during the post-mortem administration. The Board of Equalization ("BOE") has consistently held that when the value of the real property being distributed to a child exceeds the child’s distributive share, the trustee can adjust the value of the assets by encumbering the real property with a loan from a third-party lender or another beneficiary,² and the transfer will qualify for the parent-child exclusion from reassessment, referred to herein as an "exempt transfer."

The primary problem with this post-mortem technique is the difficulty obtaining a loan from a third-party lender, and the corresponding expense and possible delay in distribution. In numerous rulings, the BOE has confirmed that the source of the funds cannot be provided by the child who receives the property.³ In contrast, if the settlor grants a right of first refusal to a child in the trust document, then the funds can come from the child who receives the property, including by way of a third-party lender who makes a loan to the child that is secured by the property. In other words, if the trust document grants a child a right of first refusal to "purchase" an interest in the property from the trustee, the trustee can avoid having to secure a loan on the property, and the distribution to the child will be an exempt transfer.

However, when a trust is drafted, the settlor may not know whether a particular child or children would want to retain a particular property or want to grant a particular child a right not afforded the other children. The BOE has confirmed, in a letter to the author, that even very broadly drafted rights of first refusal will still be respected, even if the right is given to all children, and in some cases, grandchildren as well, and where the particular property over which such rights are applicable is not specified.